Glossary
Duration
A measure of a bond's price sensitivity to interest rates: a duration of 7 means about a 7% price drop for a one-point rise in yields.
Duration measures how much a bond's price is likely to change when interest rates move. It is expressed in years, and the shortcut every bond investor learns is this: for each 1-percentage-point change in yield, a bond's price moves by roughly its duration in percent, in the opposite direction. It is the main gauge of Interest-rate risk.
Two related definitions
- Macaulay duration is the weighted average time until a bond's cash flows are received, with each payment weighted by its share of the bond's present value.
- Modified duration adjusts Macaulay duration into a direct price-sensitivity measure.
What drives duration
- Longer Maturity means higher duration.
- Lower coupons mean higher duration, because more of the value comes at the end. A Zero-coupon bond's Macaulay duration equals its maturity.
- Lower yields raise duration slightly.
Limits of the shortcut
Duration is a straight-line estimate of a curved relationship. For large rate moves, the actual price change differs, a gap captured by a second measure called convexity. For bonds with call features or mortgage-backed securities, cash flows change when rates change, so analysts use effective duration instead. Duration also measures only rate risk, not Credit Risk. In 2022, long-term Treasury funds with durations near 17 years lost roughly 30% as long-term yields rose by more than two percentage points.